Equity Loans - A powerful financial tool
The equity you have
in your home can be a powerful tool in managing your overall financial
situation. Your equity, the value of your home minus your existing mortgage,
can serve as collateral for additional borrowing. While there are some
risks with this strategy (as with any borrowing), home equity loans usually
offer the attractions of lower rates, convenience and often tax benefits.
How does a home
equity loan work?
Most institutions view home equity as good collateral and are often willing
to lend you money against that equity. Lenders may issue you a special
check or a checkbook for you to access funds. There are usually forms
to sign and an approval process that is not too difficult. There may be
some form of commitment fee.
The amount they will
lend you depends on the amount of equity in your home and your other credit
characteristics. A general rule of thumb is that they will lend up to
an amount so the total debt against your home (including the first mortgage
and any other loans where your home is pledged as collateral) is less
than 80% of the current value of your home.
The interest rate
charged will usually be variable and will be pegged to some published
index, like the prime rate. There are also some institutions that offer
low "teaser" rates initially and then raise the rates after a period.
Check out the rate details.
Usually, you repay
the loan in regular installments and with minimum repayments required.
With some home equity loans, the minimum payments may only be the interest
on the loan and you may be required to repay the loan at a certain date.
You need to read the details carefully.
Home Equity Loans
Convenience - Usually institutions
make it easy to apply and their approval processes are fast. Their process
is often simpler than if you were applying for a new mortgage. Once you
are approved, their commitment acts like a line of credit. You do not
have to borrow it all at once.
Interest rates - The interest rates
charged on home equity loans are usually greater than those on first mortgages
but less than those on credit cards. Using the proceeds of a home equity
loan to pay off credit card debt will usually save you money.
Even though you are borrowing against your house, there is no requirement
that the money be used on your house. A home equity loan can be the source
of funds for college tuition or even to buy a car. Compare the rates on
an auto loan and a home equity loan the next time you are financing a
Beware of the risks
Borrowing against the equity in your home should be considered carefully.
Even though there are benefits, these types of loans are like other loans
- you pay interest and they must be paid off. Most people use home equity
loans for "conservative" purposes and avoid making risky investments or
extravagant spending with the proceeds.
Read and understand
all the details before signing. Loan documents can be confusing and the
easy process of getting this type of loan can mask the costs and risks.